equity investing in real estate through public and private...
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Equity Investing in Real Estate Through Public and Private MarketsJune 2018Brad Case, Ph.D., CFA, CAIASenior Vice President, Research & Industry Information
What is a REIT?
REITs are companies and own and manage income-producing real estate.REITs were developed to democratize real estate investment.▪ Asset and income tests ensure returns reflect real estate investment.
▪ At least 75 percent of assets are real estate.▪ At least 75 percent of income comes from ownership of real estate.
▪ Ownership tests ensure ordinary individuals are the main beneficiaries.▪ At least 100 shareholders with transferable shares.▪ Largest five shareholders cannot collectively own more than 50 percent.
▪ Distribution test ensures that real estate returns flow to individuals.▪ Must distribute at least 90 percent of taxable income in the form of dividends.▪ Distributions are deducted from taxable income to prevent double-taxation.▪ Most REITs distribute at least 100 percent of taxable income, so have no remaining
income subject to taxation at the corporate level.
▪ The tests ensure that REIT shareholders have the same tax treatment as individuals or partnerships.
What is “Public Real Estate”?
▪ “Private real estate” can be offered to qualified investors but not to the general public.▪ Private non-REITs
▪ Direct investment▪ Co-investment (including joint ventures managed by a REIT)▪ Separate accounts▪ Many private equity investment funds
▪ Private REITs (including many other private equity investment funds)
▪ “Public real estate” must be registered with the SEC and can be offered to the general public.▪ Includes real estate operating companies (REOCs) as well as REITs
▪ Public REITs may be listed or unlisted.▪ Listed REITs are traded on major stock exchanges.▪ Non-Listed REITs are sold directly to investors through broker-dealers.
▪ Equity REITs own primarily physical real estate (e.g., buildings).
▪ Mortgage REITs own primarily real estate debt (e.g., MBS).
▪ My discussion focuses on listed equity REITs.
What Should We Talk About Today?
1. Long-term investment attributes of public and private real estate▪ Correlations▪ Volatilities▪ Returns
2. Real estate in the fundamental mixed-asset portfolio
3. The current real estate market situation▪ Duration of the real estate market cycle▪ The macro and interest rate environment▪ Current REIT valuations
Long-Term Investment Attributes of Public and Private Real Estate
5
80
84
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92
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100
104
Jun. 29 Jul. 13 Jul. 27 Aug. 10 Aug. 24 Sep. 7 Sep. 21 Oct. 5 Oct. 19 Nov. 2 Nov. 16 Nov. 30 Dec. 14 Dec. 28 Jan. 11 Jan. 25 Feb. 8 Feb. 22 Mar. 8 Mar. 22
Who Is Getting Accurate Performance Measures?Public and private measures of hotel returns, 2001-2002
End of 3rd
Quarter 2001
End of 1st
Quarter 2002
NCREIFHotel Indexcontinued todecline until
2004Q1 and didn’trecover to pre-9/11levels until 2006Q2
6
0.61
0.43
Energy
0.79
0.52
Materials
0.81 0.
90
Info Tech
Upward-sloping term structure means long-term returns respond to the same drivers.
▪ Short-term returns may be affected by information that is of questionable value to investors with long horizons.
▪ Returns for most companies are driven by developments in the business cycle.
Source: Nareit analysis of monthly total returns for the Russell 3000 and S&P sector indices, January 1990 through May 2018. Note: Consumer Discretionary sector not shown for reasons of space.
Most Sectors Show an Upward-Sloping Term Structure of Correlations with the Broad Stock Market
0.83 0.
90
Financials
0.60
0.91
Telecom Services
0.66
0.90
Health Care
0.90 0.
97
Industrials
0.62
0.86
Consumer Staples
0.41
0.71
Utilities
7
0.61
0.43
Energy
0.79
0.52
Materials
0.81 0.
90
Info Tech
Upward-sloping term structure means long-term returns respond to the same drivers.
▪ Short-term returns may be affected by information that is of questionable value to investors with long horizons.
▪ Returns for most companies are driven by developments in the business cycle.
Downward-sloping term structure means long-term returns respond to differentdrivers.
▪ Returns in the Materials and Energy sectors are driven by developments in the commodities market cycle.
Source: Nareit analysis of monthly total returns for the Russell 3000 and S&P sector indices, January 1990 through May 2018. Note: Consumer Discretionary sector not shown for reasons of space.
Most Sectors Show an Upward-Sloping Term Structure of Correlations with the Broad Stock Market
0.83 0.
90
Financials
0.60
0.91
Telecom Services
0.66
0.90
Health Care
0.90 0.
97
Industrials
0.62
0.86
Consumer Staples
0.41
0.71
Utilities
8
0.58
0.26
Correlations Between REITs and Russell 3000 Index
▪ Declining REIT-stock correlation over increasing investment horizons indicates that asset returns increasingly differ as spillover (mispricing) effects are corrected.
▪ Declining correlation as errors are corrected is a sign that underlying return drivers are fundamentally different—that is, REITs and non-REITs represent different asset classes.
▪ REIT returns respond to the long real estate market cycle, whereas the broad stock market responds to the much shorter business cycle.
REITs Show a Downward-Sloping Term Structure of Correlations with the Broad Stock Market
Source: Nareit analysis of monthly total returns for the Russell 3000 and FTSE Nareit All Equity REIT Index, January 1990 through May 2018. Equity REITs were part of the S&P Financial Sector until September 2016.
0.61
0.35
Correlations Between REITs and S&P Financial Sector Index
1 month 3 months 6 months 12 months24 months 36 months 48 months 60 months
9
50
60
70
80
90
100
110
120
130
20023 20033 20043 20053 20063 20073 20083 20093 20103 20113 20123 20133 20143 20153 20163 20173
FTSE Nareit PureProperty® Index
Source: Nareit analysis of quarterly appreciation data from FTSE Nareit PureProperty Index, 2002Q3-2017Q4.
Measurement Lag in Private Real Estate
10
50
60
70
80
90
100
110
120
130
20023 20033 20043 20053 20063 20073 20083 20093 20103 20113 20123 20133 20143 20153 20163 20173
FTSE Nareit PureProperty® Index
NCREIF Transaction Based Index
Source: Nareit analysis of quarterly appreciation data from FTSE Nareit PureProperty Index and NCREIF NTBI), 2002Q3-2017Q4.
Measurement Lag in Private Real Estate
11
50
60
70
80
90
100
110
120
130
20023 20033 20043 20053 20063 20073 20083 20093 20103 20113 20123 20133 20143 20153 20163 20173
FTSE Nareit PureProperty® Index
NCREIF Transaction Based Index
CoStar Commercial RSI
Source: Nareit analysis of quarterly appreciation data from FTSE Nareit PureProperty Index, NCREIF (NTBI), and CoStar CRSI, 2002Q3-2017Q4.
Measurement Lag in Private Real Estate
12
50
60
70
80
90
100
110
120
130
20023 20033 20043 20053 20063 20073 20083 20093 20103 20113 20123 20133 20143 20153 20163 20173
FTSE Nareit PureProperty® Index
NCREIF Transaction Based Index
CoStar Commercial RSI
Real Capital Analytics CPPI
Source: Nareit analysis of quarterly appreciation data from FTSE Nareit PureProperty Index, NCREIF (NTBI), CoStar CRSI, and RCA CPPI, 2002Q3-2017Q4.
Measurement Lag in Private Real Estate
13
50
60
70
80
90
100
110
120
130
20023 20033 20043 20053 20063 20073 20083 20093 20103 20113 20123 20133 20143 20153 20163 20173
FTSE Nareit PureProperty® Index
NCREIF Transaction Based Index
CoStar Commercial RSI
Real Capital Analytics CPPI
NCREIF Property Index
Source: Nareit analysis of quarterly appreciation data from FTSE Nareit PureProperty Index, NCREIF (NPI and NTBI), CoStar CRSI, and RCA CPPI, 2002Q3-2017Q4.
Measurement Lag in Private Real Estate
14
1 2 3 4 8 12 16 20Return Measurement Horizon (Quarters)
Correlations with Simple Correction for Return Measurement Lag
Core Funds (NCREIF ODCE Index) Unlevered Core Properties (NCREIF NPI)Unlevered Core Properties (NCREIF TBI) Cambridge Associates RE Fund Index
1 2 3 4 8 12 16 20
Correlations between Contemporaneously Measured Returns▪ An upward-sloping term structure of correlations is
characteristic of indices that are in the same asset class but where measurement problems affect reported short-term returns.▪ Private real estate returns are measured with several sources of
error:▪ Transaction lag (about two quarters)▪ Appraisal lag (about one quarter)▪ Non-appraisal (one to three quarters)▪ Appraisal error (12 percent on average)
▪ Listed REIT returns are affected by spillover from non-REIT segments of the stock market.
▪ Correlations computed from short-term return measures are artificially depressed by return measurement problems.
▪ Correlations increase as the investment horizon lengthens, reflecting the correction of both return measurement problems in private real estate and mispricings in listed REITs.
▪ Cointegration analysis confirms that “the correlation between Nareit and NCREIF returns approaches one as the investment horizon lengthens.”
Upward-Sloping Term Structure of Correlations between Public and Private Real Estate
Source: Nareit analysis of quarterly total returns for the FTSE Nareit All Equity REITs Index, NCREIF Property Index, and NCREIF ODCE Index, 1978Q1-2018Q1 and the Cambridge Associates Real Estate Fund Index, 1986Q1-2017Q4. Quotation is from “The Long-Run Dynamics Between Direct and Securitized Real Estate” by Oikarinen, Hoesli & Serrano [2011]. 15
Source: https://www.reit.com/sites/default/files/media/DataResearch/NareitCEMStudy2017.pdf
CEM Benchmarking: REIT Correlations with Equities and Unlisted Real Estate
U.S. Large Cap Public Equity
U.S. Small Cap Public Equity
Non-U.S. Public Equity Private Equity Unlisted Real
Estate REITs
U.S. Large Cap Public Equity 1.00 0.92 0.89 0.85 0.49 0.55
U.S. Small Cap Public Equity 1.00 0.89 0.88 0.58 0.64
Non-U.S.Public Equity 1.00 0.91 0.55 0.58
Private Equity 1.00 0.54 0.50
Unlisted Real Estate 1.00 0.92
REITs 1.00
Key Correlations: Equities, REITs and Unlisted Real Estate1998-2015
What Should We Talk About Today?
1. Long-term investment attributes of public and private real estate▪ Correlations ✓ both provide asset class diversification
▪ Volatilities▪ Returns
2. The fundamental mixed-asset portfolio
3. The current real estate market situation▪ Duration of the real estate market cycle▪ The macro and interest rate environment▪ Current REIT valuations
Capital Appreciation Total Return
Unlevered REITs Unlevered Private Real Estate Unlevered REITs Unlevered Private
Real Estate
Apartment 10.3% 10.2% 10.3% 10.2%
Industrial 10.8% 10.0% 10.8% 10.0%
Office 11.0% 10.2% 11.0% 10.2%
Retail 11.6% 10.5% 11.7% 10.7%
East Region* 11.5% 10.5% 11.6% 10.6%
Midwest Region* 10.5% 9.6% 10.5% 9.7%
South Region* 9.9% 9.9% 9.9% 10.0%
West Region* 11.4% 10.2% 11.4% 10.2%
Aggregate* 10.7% 10.1% 10.7% 10.2%
Source: Nareit analysis of quarterly data from NCREIF Transaction Based Index (NTBI) and FTSE Nareit PureProperty® Index Series, 2002Q3-2017Q4. Quarterly returns for the NTBI are based on all properties in the NCREIF Property Index (NPI) data base that transacted at any time during each quarter; quarterly returns for the PureProperty are based on only the last transaction of stock for each constituent REIT during each quarter. *Includes heath care and hotel properties, which are typically slightly more volatile.
Public and Private Real Estate Have Virtually Identical Volatilities, Conditional on the Use of Leverage
Private real estate is illiquid, and therefore
significantly more risky than public real estate.
18
What Should We Talk About Today?
1. Long-term investment attributes of public and private real estate▪ Correlations ✓ both provide asset class diversification
▪ Volatilities ✓ almost identical equity-like volatility for both
▪ Returns
2. The fundamental mixed-asset portfolio
3. The current real estate market situation▪ Duration of the real estate market cycle▪ The macro and interest rate environment▪ Current REIT valuations
Form of Real Estate Investment Typical Leverage Average Fees and
ExpensesDuration of Real Estate Cycle
Full-CycleNet Total Returns
Unlevered Properties 0 percent ≈100 basis points 17¾ years
1990Q3 - 2008Q2275 percent
7.7 percent / year
Open-End Diversified Core Funds
≈22 percent 107 basis points 17¾ years1990Q3 - 2008Q2
272 percent7.7 percent / year
Value-Add Private Equity Real Estate Funds
≈51 percent 170 basis points 17¼ years1990Q3 - 2007Q4
348 percent8.9 percent / year
Opportunistic Private Equity Real Estate Funds
≈64 percent 257 basis points 17½ years1990Q3 - 2008Q1
716 percent12.9 percent / year
Exchange-Traded Equity REITs ≈38 percent ≈52 basis points 17½ years
1989Q3 - 2007Q1802 percent
13.4 percent / year
Source: Nareit analysis of quarterly net total returns. Unlevered properties: NCREIF Property Index, assuming fees and expenses of 25 basis points per quarter. Open-End Diversified Core Funds: NCREIF ODCE Index. Value-Add and Opportunistic Private Equity Real Estate Funds: NCREIF/Townsend Funds Index. Exchange-Traded Equity REITs: FTSE Nareit All Equity REIT Index, assuming fees and expenses of 13 basis points per quarter. Returns are not adjusted for differences in leverage.
Net Total Returns Through a Full Real Estate Market Cycle
REITs significantly outperformed every category of private
real estate, especially at the property level.
20
Source: Nareit analysis of data from NCREIF Property Index (unlevered core properties, NCREIF ODCE Index (core funds), NCREIF/Townsend Fund Indices (value added and opportunistic funds), and FTSE Nareit All Equity REITs Index (equity REITs). Expenses for equity REITs are estimated at 50 bps per year, distributed equally across all months; expenses for unlevered core properties are assumed to equal 100 bps per year, distributed equally across all quarters. Expenses are attributed to income returns only, in accordance with ODCE. Assumes no reinvestment of net income.
Net Income and Capital Appreciation Components of Net Total Return, 1988q3-2013q3
6.35
3.69
2.66
3.44 3.38
0.06
2.963.26
-0.30
3.443.12
0.31
5.73
2.89 2.85
-1
0
1
2
3
4
5
6
7
Total Return (net) Income (net) Capital Appreciation
Equity REITsUnlevered Core PropertiesCore FundsValue-Add FundsOpportunistic Funds
Near-zero capital
appreciation over 25 years?
21
▪ Kiehelä & Falkenbach (2015: PERE funds constantly and significantly underperformed the public market.
▪ Ling, Naranjo & Scheick (2015): Public market real estate returns outperform comparable private market returns.
▪ Andonov, Eichholtz & Kok (2014): REITs delivered a higher gross return as compared to direct real estate investments.
▪ Ling & Naranjo (2014): Unlevered core REITs outperformed their private market benchmark by 49 basis points (annualized) over the 1994-2012 sample period.
▪ Fisher & Hartzell (2013): Real estate private equity rarely out-performed REITs, and for some vintages the underperformance was substantial.
▪ Alcock, Baum, Colley & Steiner (2013): We find evidence for systematic underperformance (by private equity real estate investment funds).
▪ Andonov, Kok & Eichholtz (2013): Indirect real estate has done better for pension funds in three ways: the gross return was higher, the cost wedge between gross and net was lower, and the benchmark-adjusted return was positive.
▪ Urban Land Institute (2011): This research concludes that real estate funds in general have not delivered the required risk/return characteristics that investors would have expected or are led to believe.
▪ Bond & Mitchell (2010): The widespread finding is that very few managers investing in the direct real estate market appear to be able to generate excess risk-adjusted returns.
▪ Tsai (2007): At the all-sector level, the difference in mean returns between the REIT index and NPI is found to be 2.66% after return restatement.
▪ Riddiough, Moriarty & Yeatman (2005): Annualized NCREIF index returns over the entire sample period were 7.36%, compared to an adjusted annualized return of 10.44% for the REIT index.
▪ Pagliari, Scherer & Monopoli (2005): The data indicate that REITs outperformed private-market real estate by approximately 3.0% per annum.
Every Academic Study Ever Conducted Has Found that Public Real Estate Outperformed Private Real Estate
22
Source: CEM Benchmarking, 2017
CEM Benchmarking: REITs Outperformed Other Major Asset Classes: 1998 to 2015
-4 -2 0 2 4 6 8 10 12 14
U.S. Other Bonds
Hedgefunds / TAA
U.S. Broad Bonds
Non-U.S. Bonds
Other Real Assets
U.S. Long Bonds
Non-U.S. Equities
U.S. Large Cap
Unlisted Real Estate
U.S. Small Cap
Private Equity
REITs
Annual Net Total Return and Expense by Asset Class(1998 – 2015)
Net Total ReturnExpenses
Expense Impact (%) Average Annual Total Return Net of Fees (%)
REITs provided higheraverage net total returns thanall other asset categories over: all three available 15-year periods five of the eight 10-year periods four of the thirteen 5-year periods six of the fifteen 3-year periods
Source: CEM Benchmarking, 2017
CEM Benchmarking: REITs Delivered Superior Risk Adjusted Returns
0
5
10
15
20
25
30
35
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7Volatility in percentSharpe Ratio Sharpe Ratio
Volatility
Volatility and Risk Adjusted Returns by Asset Class(1998 - 2015)
REITs provided higherSharpe ratios than all otherequity asset categories over: all three available 15-year periods five of the eight 10-year periods four of the 13 5-year periods three of the 15 3-year periods
▪ Transparency vs Opacity▪ Myth: investment managers must protect their ideas and strategies.▪ Reality: opacity protects managers when they make poor decisions; transparency subjects them to
capital market discipline.
▪ Liquidity vs Lock-Up▪ Myth: good investments can be made only if investors lock up capital.▪ Reality: illiquidity protects managers when they make poor decisions; liquidity subjects them to
capital market discipline.
▪ Corporate Governance / Alignment of Interest▪ Incentive compensation for REIT executives is almost entirely restricted stock.▪ Management fees and “promotes” drive a wedge between the interests of private equity fund
managers and investors.
▪ Access to Capital▪ Myth: the distribution requirement prevents REITs from having access to capital, so prevents them
from making good investments.▪ Reality: REITs have access to capital from all parts of the market; unrestricted capital enables
managers to make poor decisions, while the REIT distribution requirement subjects them to capital market discipline.
▪ Public/Private Arbitrage Opportunity▪ REITs tend to buy properties (and sell securities) when properties are inexpensive on the private
market, and sell properties (and buy securities) when properties are expensive on the private market.
▪ REITs own about 20 percent of institutional-quality real estate assets.
Why Have REITs Outperformed Private Real Estate?
What Should We Talk About Today?
1. Long-term investment attributes of public and private real estate▪ Correlations ✓ both provide asset class diversification
▪ Volatilities ✓ almost identical equity-like volatility for both
▪ Returns ✓ REITs have consistently outperformed private real estate
2. The fundamental mixed-asset portfolio
3. The current real estate market situation▪ Duration of the real estate market cycle▪ The macro and interest rate environment▪ Current REIT valuations
Real Estate in the Fundamental Mixed-Asset Portfolio
27
Source: Nareit analysis based on a DCC-GARCH (Dynamic Conditional Correlation – Generalized Autoregressive Conditional Heteroskedasticity: Engle 2002) model using monthly total returns through May 2018. Equity REITs (FTSE Nareit All U.S. Equity REIT), mortgage REITs (FTSE Nareit Mortgage REIT), and U.S. large-cap stocks (Russell 1000) from January 1972; non-U.S. listed property companies (FTSE EPRA/Nareit Developed x-US) from January 1990; REIT preferred stocks (BofA/ML Preferred Stock REITs) from January 1997; small-cap value stocks (Russell 2000 Value) from January 1979; non-U.S. stocks (MSCI AC World ex-US) from January 1988; U.S. bonds (Bloomberg Barclays US Aggregate) from January 1976; non-U.S. bonds (Bloomberg Barclays Global Aggregate x-USD) from January 1990.
REITs have Relatively Low Correlations with All Major U.S. and Global Asset Classes
Listed U.S. Mortgage
REITs
Non-U.S. LPCs
U.S. REIT Preferred
Stocks
U.S. Large-Cap Stocks
U.S. Small-Cap Value
Stocks
Non-U.S. Stocks U.S. Bonds Non-U.S.
Bonds Volatility (%)
Equity REITs 0.59 0.64 0.44 0.45 0.57 0.40 0.33 0.25 13.8
Mortgage REITs 0.42 0.43 0.47 0.54 0.28 0.41 0.08 16.2
Non-U.S. ListedProperty Companies 0.28 0.67 0.52 0.84 0.23 0.59 15.1
U.S. REIT PreferredStocks 0.10 0.22 -0.09 0.63 0.14 7.7
U.S. Large-CapStocks 0.71 0.81 0.05 0.21 11.1
U.S. Small-Cap Value Stocks 0.48 0.11 0.09 15.2
Non-U.S. Stocks 0.07 0.40 13.3
U.S. Bonds 0.47 3.1
Non-U.S. Bonds 7.7
28
Steady Dividends are an Important Component of Total Returns
Source: Nareit analysis of monthly total returns in USD for the FTSE Nareit All Equity REIT Index, FTSE EPRA/Nareit Developed Real Estate Index, Russell 3000 Total U.S. Stock Market Index, and MSCI All-Country World Stock Index as of May 2018. 29
▪ REIT income returns have averaged 5.40 percent per year▪ 52 percent of their total
▪ U.S. stock income returns have averaged 2.00 percent per year▪ 20 percent of their total
▪ U.S REITs distributed $58 billion in dividends in 2017.
$0
$2
$4
$6
$8
$10
$12
$14
$16
$18
Dec 89 Dec 94 Dec 99 Dec 04 Dec 09 Dec 14
FTSE NareitAll Equity REIT
$0
$2
$4
$6
$8
$10
$12
$14
$16
$18
Dec 89 Dec 94 Dec 99 Dec 04 Dec 09 Dec 14
Russell 3000
$0
$2
$4
$6
$8
$10
$12
$14
$16
$18
Dec 89 Dec 94 Dec 99 Dec 04 Dec 09 Dec 14
FTSE EPRA/NareitDeveloped Real Estate
Cumulative Capital Gains with ReinvestmentCumulative Dividends with ReinvestmentInitial Investment
$0
$2
$4
$6
$8
$10
$12
$14
$16
$18
Dec 89 Dec 94 Dec 99 Dec 04 Dec 09 Dec 14
MSCI ACWI
Cumulative Capital Gains with ReinvestmentCumulative Dividends with ReinvestmentInitial Investment
Source: Wilshire Associates, 2017.
REITs Have an Important Role in Target-Date Funds
21%20%
20%18%
20%
19%
Mean-Variance OptimizationExcluding REITs
Mean-Variance OptimizationIncluding Global REITs
Surplus OptimizationIncluding Global REITs
Cash 0.0% 0.0% 0.0%
TIPS 5.2% 4.1% 0.0%
U.S. Bonds 21.7% 26.3% 32.8%
High Yield 5.9% 1.8% 0.0%
Non-U.S. Bonds 6.7% 4.5% 5.1%
Large Cap 27.6% 27.7% 23.6%
Small Cap 7.0% 6.0% 1.0%
Global REITs 0.0% 6.5% 11.6%
Non-U.S. Dev'd Mkts 20.0% 18.0% 15.0%
Emerging Mkts 5.8% 5.2% 11.1%
Commodities 0.0% 0.0% 0.0%
REITs Have an Important Role in Target-Date Funds
21%20%
20%18%
20%
19%
Mean-Variance OptimizationExcluding REITs
Mean-Variance OptimizationIncluding Global REITs
Surplus OptimizationIncluding Global REITs
Cash 0.0% 0.0% 0.0%
TIPS 5.2% 4.1% 0.0%
U.S. Bonds 21.7% 26.3% 32.8%
High Yield 5.9% 1.8% 0.0%
Non-U.S. Bonds 6.7% 4.5% 5.1%
Large Cap 27.6% 27.7% 23.6%
Small Cap 7.0% 6.0% 1.0%
Global REITs 0.0% 6.5% 11.6%
Non-U.S. Dev'd Mkts 20.0% 18.0% 15.0%
Emerging Mkts 5.8% 5.2% 11.1%
Commodities 0.0% 0.0% 0.0%
Inflation Protection
Source: Wilshire Associates, 2017.
REITs Have an Important Role in Target-Date Funds
21%20%
20%18%
20%
19%
Mean-Variance OptimizationExcluding REITs
Mean-Variance OptimizationIncluding Global REITs
Surplus OptimizationIncluding Global REITs
Cash 0.0% 0.0% 0.0%
TIPS 5.2% 4.1% 0.0%
U.S. Bonds 21.7% 26.3% 32.8%
High Yield 5.9% 1.8% 0.0%
Non-U.S. Bonds 6.7% 4.5% 5.1%
Large Cap 27.6% 27.7% 23.6%
Small Cap 7.0% 6.0% 1.0%
Global REITs 0.0% 6.5% 11.6%
Non-U.S. Dev'd Mkts 20.0% 18.0% 15.0%
Emerging Mkts 5.8% 5.2% 11.1%
Commodities 0.0% 0.0% 0.0%
Inflation Protection
Strong, Steady Income
Source: Wilshire Associates, 2017.
REITs Have an Important Role in Target-Date Funds
21%20%
20%18%
20%
19%
Mean-Variance OptimizationExcluding REITs
Mean-Variance OptimizationIncluding Global REITs
Surplus OptimizationIncluding Global REITs
Cash 0.0% 0.0% 0.0%
TIPS 5.2% 4.1% 0.0%
U.S. Bonds 21.7% 26.3% 32.8%
High Yield 5.9% 1.8% 0.0%
Non-U.S. Bonds 6.7% 4.5% 5.1%
Large Cap 27.6% 27.7% 23.6%
Small Cap 7.0% 6.0% 1.0%
Global REITs 0.0% 6.5% 11.6%
Non-U.S. Dev'd Mkts 20.0% 18.0% 15.0%
Emerging Mkts 5.8% 5.2% 11.1%
Commodities 0.0% 0.0% 0.0%
Inflation Protection
Strong, Steady Income
StrongRisk-Adjusted
Returns
Source: Wilshire Associates, 2017.
Note: Allocations to any asset class will depend on the optimization methodology employed, the time period covered by the analysis, the assets included in the opportunity set, and the expected return assumptions.
Portfolio Allocations to Real EstateDifferent researchers, methodologies and time periods
Morningstar AnalysisMean Variance Optimization
1990-2007
Morningstar AnalysisMean Variance Optimization
1990-2010
Morningstar AnalysisFat Tail Optimization
1990-2009
Wilshire AnalysisSurplus Optimization
1990-2012
Morningstar AnalysisLiability Relative Investing
1990-2009
21%20%
20%18%
20%
Wilshire AnalysisSurplus Optimization
1990-2016
19%
34
Real Estate is One of the Four FundamentalAsset Classes▪ Real estate investment has long been recognized
as a core asset class by large and small institutional investors, including pension and retirement funds.
“Basically, there are only four types of investment categories that you need to consider: Cash, Bonds, Common Stocks and Real Estate.”
– Burton G. Malkiel, PhD (Economist, Princeton),The Random Walk Guide to Investing
▪ Real estate investment provides a unique combination of attributes:
▪ Hybrid investment returns with elements of both stocks and bonds
▪ Investment grade real property assets provide a measure of inflation hedging
▪ Real estate cycle does not coincide with the overall economic cycle
▪ Moderate correlation with other assets over time provides potential diversification
What Should We Talk About Today?
1. Long-term investment attributes of public and private real estate▪ Correlations ✓ both provide asset class diversification
▪ Volatilities ✓ almost identical equity-like volatility for both
▪ Returns ✓ REITs have consistently outperformed private real estate
2. The fundamental mixed-asset portfolio ✓
3. The current real estate market situation▪ Duration of the real estate market cycle▪ The macro and interest rate environment▪ Current REIT valuations
The CurrentReal Estate MarketSituation
37
Typical Duration of the Cyclical Real Estate Bull Market is 15-16 Years
Monthly data as of May 2018. Source: Nareit analysis of FTSE Nareit All Equity REIT Index total returns. 38
▪ The long cyclical real estate bull market may include non-cyclical months or quarters of negative performance.
▪ To date the duration of the current cyclical bull market is far less than previous cyclical bull markets.
▪ Average total returns to date have been comparable to the equivalent segment of previous cyclical bull markets, despite beginning from the trough of a liquidity crisis.
full bull market:
16 yrs 3 mos10/90 – 1/07+17.3% per yr
full bull market:
14 yrs 8 mos12/74 – 8/89+19.9% per yr
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16Years after start of bull market
first 9 yrs 3 moOct 90 – Jan 00
+12.7% per yr
2/09 - ?first 9 yrs 3 mo+19.1% per yr
first 9 yrs 3 moDec 74 – Mar 84
+23.5% per yr
Typical Duration of Cyclical Real Estate Expansion is 13-16 Years
Monthly data as of May 2018. Source: Nareit analysis of FTSE Nareit All Equity REIT Index total returns. 39
▪ The cyclical expansion starts when the recovery from the previous cyclical downturn has been completed.
▪ The long cyclical real estate expansion may include non-cyclical months or quarters of negative performance.
▪ To date the duration of the current cyclical expansion is far less than previous cyclical expansions.
▪ Average total returns to date have been far less than during previous cyclical expansions.
full expansion:15 yrs 10 mos3/91 – 1/07
+15.8% per yr
full expansion:12 yrs 11 mos9/76 – 8/89
+18.7% per yr
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15Years after start of expansion
first 5 yrs 10 mosSep 76 – Jul 82 +17.6% per yr
7/12 - ?first 5 yrs 10 mos
+8.2% per yr
first 5 yrs 10 mosMar 91 – Jan 97
+16.7% per yr
Typical Duration of the Real Estate Market Cycleis Close to 18 Years
Monthly data as of May 2018. Source: Nareit analysis of FTSE Nareit All Equity REIT Index total returns.
▪ The long real estate market cycle may encompass several weak non-cyclicalmonths or quarters.
▪ To date the duration of the current cycle is far less than previous cycles.
▪ Average total returns to date have been far lower than over full previous market cycles.
▪ The typical duration of the real estate market cycle was first observed in 1933 by the great real estate market researcher Dr. Homer Hoyt.
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17Years after start of market cycle
full cycle9/72 – 8/89
17 years+13.9% per yr
full cycle8/89 – 1/0717½ years
+14.3% per yr
1/07-?first 11 yrs 3 mo
+4.2% per yr
first 11 yrs 3 moAug 89 – Sep 00
+9.9% per yr
first 11 yrs 3 moSep 72 – Oct 83+14.0% per yr
40
What Should We Talk About Today?
1. Long-term investment attributes of public and private real estate▪ Correlations ✓ both provide asset class diversification
▪ Volatilities ✓ almost identical equity-like volatility for both
▪ Returns ✓ REITs have consistently outperformed private real estate
2. The fundamental mixed-asset portfolio ✓
3. The current real estate market situation▪ Duration of the real estate market cycle ✓ still young
▪ The macro and interest rate environment▪ Current REIT valuations
Typical Signs of a Downturn Are Absent
Source: Nareit analysis of data from U.S. Bureau of Economic Analysis and Haver Analytics.
▪ Recessions have typically followed periods when the share of GDP from cyclical segments was abnormally high.
▪ Currently the share of GDP from cyclical segments is still abnormally low.
42
18%
20%
22%
24%
26%
28%
30%
32%
1972
Q1
1974
Q1
1976
Q1
1978
Q1
1980
Q1
1982
Q1
1984
Q1
1986
Q1
1988
Q1
1990
Q1
1992
Q1
1994
Q1
1996
Q1
1998
Q1
2000
Q1
2002
Q1
2004
Q1
2006
Q1
2008
Q1
2010
Q1
2012
Q1
2014
Q1
2016
Q1
2018
Q1
Cyclical Share of GDP
Construction Still Hasn’t Recovered to Normal
Source: Nareit analysis of data from U.S. Census Bureau, U.S. Bureau of Economic Analysis, and Haver Analytics.
▪ From 1993 until the start of the Great Financial Crisis the real value of new construction put in place averaged more than 1.5 percent of GDP.
▪ As a result of the GFC new construction plummeted to less than half its previous average.
▪ Since the GFC construction grew to almost 1.4 percent of GDP before declining slightly during 2017.
43
0.0%
0.2%
0.4%
0.6%
0.8%
1.0%
1.2%
1.4%
1.6%
1.8%
2.0%
1993
Q1
1994
Q1
1995
Q1
1996
Q1
1997
Q1
1998
Q1
1999
Q1
2000
Q1
2001
Q1
2002
Q1
2003
Q1
2004
Q1
2005
Q1
2006
Q1
2007
Q1
2008
Q1
2009
Q1
2010
Q1
2011
Q1
2012
Q1
2013
Q1
2014
Q1
2015
Q1
2016
Q1
2017
Q1
Value of Construction Put in Placeas a Share of GDP
RetailOfficeMultifamilyHealth CareLodgingAverage 1991-2008
Real Estate Operating Fundamentals Remain Favorable
Source: Nareit analysis of data from CoStar.
▪ Net absorption (i.e. growth of demand) exceeds new supply for most property types in most markets.
▪ New construction is in check and vacancy rates are low, supporting modest increases in rents.
44
87%
88%
89%
90%
91%
92%
93%
94%
95%
96%
97%
2006
Q1
2007
Q1
2008
Q1
2009
Q1
2010
Q1
2011
Q1
2012
Q1
2013
Q1
2014
Q1
2015
Q1
2016
Q1
2017
Q1
2018
Q1
Average Occupancy at REIT-Owned Properties
All Equity REITsApartmentsIndustrialOfficeRetail
-6%
-3%
0%
3%
6%
9%
2006
Q1
2007
Q1
2008
Q1
2009
Q1
2010
Q1
2011
Q1
2012
Q1
2013
Q1
2014
Q1
2015
Q1
2016
Q1
2017
Q1
2018
Q1
Growth in Same-Store NOI at REIT-Owned Properties
All Equity REITsApartmentIndustrialOfficeRetail
-120
-80
-40
0
40
80
120
-2.5 -2 -1.5 -1 -0.5 0 0.5 1 1.5 2 2.5
12-M
onth
Tot
al R
etur
n (p
erce
nt)
Change in Interest rates
REIT returnswere positive
in 87 percent ofrising-rate periods
-60
-40
-20
0
20
40
60
-2.5 -2 -1.5 -1 -0.5 0 0.5 1 1.5 2 2.5
REI
T M
inus
S&P
500
Ret
urn
(per
cent
)
Change in Interest Rates
REIT returnsexceeded
the S&P 500in 53 percent of
rising-rate periods
REITs Have Often Outperformed the Broad Stock Market During Periods of Rising Interest Rates
Source: Nareit analysis of quarterly intervals of 12-month rolling returns for Nareit All Equity REIT Index, S&P 500, and 10-Year Treasury Constant Maturity Rate (via FRED). 45
What Should We Talk About Today?
1. Long-term investment attributes of public and private real estate▪ Correlations ✓ both provide asset class diversification
▪ Volatilities ✓ almost identical equity-like volatility for both
▪ Returns ✓ REITs have consistently outperformed private real estate
2. The fundamental mixed-asset portfolio ✓
3. The current real estate market situation▪ Duration of the real estate market cycle ✓ still young
▪ The macro and interest rate environment ✓ favorable
▪ Current REIT valuations
Dividend Yield Spreads have Signaled Future REIT Performance
Source: Nareit analysis of monthly total returns from the FTSE Nareit All Equity REIT Index and Russell 3000 stock index, December 1990 – May 2018; yield spread is month-end average equity REIT yield minus month-end market yield on Moody’s Baa-rated bonds (via FRED).
1.4%
8.4%
13.5
%
12.9
%
17.3
%
18.9
%
-3.3
%
-3.9
%
-0.9
%
1.1%
7.0%
11.2
%
-5%
0%
5%
10%
15%
20%
< -2.0% -2.0% - -1.6% -1.6% - -1.3% -1.3% - -1.0% -1.0% - -0.5% > -0.5%
Aver
age
Tota
l Ret
urn,
Sub
sequ
ent T
hree
Yea
rs
Equity REIT Yield minus Baa-Rated Corporate Bond Yield
Equity REIT TR
EqREITs minus Stocks
▪ The spread between average REIT dividend yields and the yields on other income-oriented investments has provided a valuable signal for future REIT total returns and for future REIT outperformance relative to the broad stock market.▪ Yield spread to Baa-rated corporates (shown)▪ Yield spread to high-quality corporates▪ Yield spread to 10-year Treasuries
▪ Current REIT dividend yield spreads are relatively high, suggesting strong future REIT total returns and strong future REIT outperformance relative to the broad stock market.
6/1/17:yield spread =-0.61 percent
47
Regression Analysis Also Suggests Bullish Future REIT Return Expectations
Source: Nareit analysis of monthly total returns from the FTSE Nareit All Equity REIT Index and Russell 3000 stock index, December 1990 – May 2018; yield spread is month-end average equity REIT yield minus month-end market yield on Moody’s Baa-rated bonds (via FRED).
▪ Regression suggests that average annualized returns over subsequent three-year periods have generally been about 21.6 percent plus 7.68 times the yield spread to high-yield corporates.
▪ The -0.61 percent yield spread at the beginning of June 2018 suggests that equity REIT returns will average around 17 percent per year over the next three years and outperform the broad stock market by around six percentage points per year.
▪ The analysis provides qualitatively similar conclusions for yield spreads to other assets, and for future periods other than the next three years.
48
May-1816.8%
-5%
0%
5%
10%
15%
20%
25%
30%
35%
40%
-3.0%
-2.0%
-1.0%
0.0%
1.0%
2.0%
Dec
. 90
Dec
. 92
Dec
. 94
Dec
. 96
Dec
. 98
Dec
. 00
Dec
. 02
Dec
. 04
Dec
. 06
Dec
. 08
Dec
. 10
Dec
. 12
Dec
. 14
Dec
. 16
Aver
age
List
ed E
q R
EIT
Div
iden
d Yi
eld
Spre
ad to
Baa
-rate
d C
orpo
rate
s
Yield Spread (left scale)Predicted TR (right scale)
Public Real Estate Seems Inexpensive Relative to Private Real Estate
Source: Green Street Advisors, Inc., based on NAV estimates for U.S. REITs under coverage (excluding hotels) as of June 1, 2018.
-50%
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
50%
Jan. 1990 Jan. 1994 Jan. 1998 Jan. 2002 Jan. 2006 Jan. 2010 Jan. 2014 Jan. 2018
Estimated Average Equity REIT Stock Price Premium/Discount to NAV (P-NAV)
Average during Modern REIT Era
Estimated P-NAV
▪ “On average, REITs have traded roughly at parity relative to asset value/NAV over the last twenty+ years. Based on prevailing share prices and the resultant observed premium/discount, public-market investors are effectively assuming that real estate values will change by -9%.”
▪ “Assuming that unlevered property values revert to their long-term relationship relative to fixed-income alternatives, REIT share prices should change by +11%.”
49
15.6
%
14.7
%
12.8
%
9.8%
8.8%
8.8%
7.8%
5.3%
3.0%
-0.7
% -2.1
%
-0.7
%
-3%
0%
3%
6%
9%
12%
15%
18%
< -10% -10% - -5% -5% - +1% +1% - +7% +7% - +14% > +14%
Aver
age
Tota
l Ret
urn,
Sub
sequ
ent F
ive
Year
s
Green Street Advisors Estimate of Average Equity REIT P-NAV
Equity REIT TREqREITs minus Stocks
Equity REIT Premiums to Net Asset Value Also Signal Future Performance
Source: Nareit analysis of monthly total returns from the FTSE Nareit All Equity REIT Index and Russell 3000 stock index, December 1990 – May 2018; yield spread is month-end average equity REIT yield minus month-end market yield on Moody’s Baa-rated bonds (via FRED).
▪ The average equity REIT stock price premium / discount to estimated net asset value (P-NAV) has provided a valuable signal for future REIT total returns and for future REIT outperformance relative to the broad stock market.
▪ Current REIT stock prices are abnormally low relative to net asset value, suggesting strong future REIT total returns and strong future REIT outperformance relative to the broad stock market.
6/1/18:averageP-NAV =
-14%
50
What Should We Talk About Today?
1. Long-term investment attributes of public and private real estate▪ Correlations ✓ both provide asset class diversification
▪ Volatilities ✓ almost identical equity-like volatility for both
▪ Returns ✓ REITs have consistently outperformed private real estate
2. The fundamental mixed-asset portfolio ✓
3. The current real estate market situation▪ Duration of the real estate market cycle ✓ still young
▪ The macro and interest rate environment ✓ favorable
▪ Current REIT valuations ✓ all metrics seem to be in distinctly bullish ranges
Nareit Resources
52
▪ Real Estate Investment SmartBriefDaily email aggregates and summarizes the most important news in the real estate investment industry.
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Nareit Market Commentary Blog Analysis of the macro- and micro-economic fundamentals impacting the REIT and commercial real estate industry.
Nareit REIT Report Podcasts Interviews with REIT leaders on the trends shaping the industry.
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Contact
If you have any questions, please contact us
Brad Case, Ph.D., CFA, CAIASenior Vice President, Research & Industry Informationdirect: [email protected] with me on LinkedIn
Nareit1875 I Street, NW, Suite 600Washington, D.C. 20006-5413reit.com
Disclaimer
Nareit is the worldwide representative voice for REITs and listed real estate companies with an interest in U.S. real estate and capital markets. Members are REITs and other businesses that own, operate and manage income-producing real estate, as well as those firms and individuals who advise, study and service those businesses. Nareit is the exclusive registered trademark of Nareit, 1875 I St., NW, Suite 600, Washington, DC 20006-5413. Follow us on REIT.com.
Copyright© 2018 by Nareit. All rights reserved.
This information is solely educational in nature and is not intended by Nareit to serve as the primary basis for any investment decision. Nareit is not acting as an investment adviser, investment fiduciary, broker, dealer or other market participant, and no offer or solicitation to buy or sell any security or real estate investment is being made. Investments and solicitations for investment must be made directly through an agent, employee or representative of a particular investment or fund and cannot be made through Nareit. Nareit does not allow any agent, employee or representative to personally solicit any investment or accept any monies to be invested in a particular security or real estate investment.
All REIT data are derived from, and apply only to, publicly traded securities. While such data are believed to be reliable when prepared or provided, such data are subject to change or restatement. Nareit does not warrant or guarantee such data for accuracy or completeness, and shall not be liable under any legal theory for such data or any errors or omissions therein. See http://reit.com/TermsofUse.aspx for important information regarding this data, the underlying assumptions and the limitations of Nareit’s liability therefore, all of which are incorporated by reference herein.
Performance results are provided only as a barometer or measure of past performance, and future values will fluctuate from those used in the underlying data. Any investment returns or performance data (past, hypothetical or otherwise) shown herein or in such data are not necessarily indicative of future returns or performance.
Before an investment is made in any security, fund or investment, investors are strongly advised to request a copy of the prospectus or other disclosure or investment documentation and read it carefully. Such prospectus or other information contains important information about a security’s, fund’s or other investment’s objectives and strategies, risks and expenses. Investors should read all such information carefully before making an investment decision or investing any funds. Investors should consult with their investment fiduciary or other market professional before making any investment in any security, fund or other investment.